PILLARSTONE CAPITAL REIT MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

Unless the context otherwise requires, all references in this report to the
“Company,” “we,” “us” or “our” are to Pillarstone Capital REIT and its
consolidated subsidiaries.

                           Forward-Looking Statements

The following discussion should be read in conjunction with our unaudited
condensed consolidated financial statements and the notes thereto in this
Quarterly Report on Form 10-Q.


This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of the federal securities laws, including discussion and analysis of
our financial condition, anticipated capital expenditures required to complete
projects, amounts of anticipated cash distributions to our shareholders in the
future and other matters. These forward-looking statements are not historical
facts but are the intent, belief or current expectations of our management based
on its knowledge and understanding of our business and industry. Forward-looking
statements are typically identified by the use of terms such as "may," "will,"
"should," "potential," "predicts," "anticipates," "expects," "intends," "plans,"
"believes," "seeks," "estimates" or the negative of such terms and variations of
these words and similar expressions, although not all forward-looking statements
include these words. These statements are not guarantees of future performance
and are subject to risks, uncertainties and other factors, some of which are
beyond our control, are difficult to predict and could cause actual results to
differ materially from those expressed or forecasted in the forward-looking
statements.

Forward-looking statements that were true at the time made may ultimately prove
to be incorrect or false. You are cautioned not to place undue reliance on
forward-looking statements, which reflect our management's view only as of the
date of this Quarterly Report on Form 10-Q. We undertake no obligation to update
or revise forward-looking statements to reflect changed assumptions, the
occurrence of unanticipated events or changes to future operating results.

Factors that could cause actual results to differ materially from any
forward-looking statements made in this Report include:


•uncertainties related to the COVID-19 pandemic, including the unknown duration
and economic, operational and financial impacts of the COVID-19 pandemic and the
actions taken or contemplated by U.S. and local governmental authorities or
others in response to the pandemic on our business, employees and tenants,
including, among others, (a) changes in tenant demand for our properties; (b)
financial challenges confronting tenants, including as a result of decreased
customers' willingness to visit our tenants' businesses, and potential renewed
mandated shelter in place orders that may prevent customers from visiting some
of our tenants' businesses and the impact of these issues on our ability to
collect rent from our tenants; (c) limited ability to access the capital markets
and other sources of financing on attractive terms or at all, and (d) prolonged
measures to contain the spread of COVID-19;

•legislative or regulatory changes, including the impact of the legislation
commonly known as the Tax Cuts and Jobs Act


•adverse economic or real estate developments or conditions in Texas, including
as a result of a surge in COVID-19 cases in such areas and the impact on our
tenants' ability to pay their rent, which could result in bad debt allowances or
straight-line rent reserve adjustments;

•increases in interest rates and operating costs;

•availability and terms of capital and financing, both to fund our operations
and to refinance our indebtedness as it matures, in each case, on terms
favorable to the Company;

•decreases in rental rates or increases in vacancy rates;
•litigation risks;

•lease-up risks, including leasing risks arising from exclusivity and consent
provisions in leases with significant tenants;

•the impact of public health crises and pandemics, such as the COVID-19
outbreak;

•cybersecurity attacks, loss of confidential information and other business
disruptions;

•our inability to renew tenants or obtain new tenants upon the expiration of
existing leases; and

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•our inability to generate sufficient cash flows due to market conditions,
competition, uninsured losses, changes in tax or other applicable laws.

In addition, an investment in the Company involves numerous risks that potential
investors should consider carefully, including, without limitation:


•our cash resources are limited;
•we have a history of losses;
•we have not raised funds through a public equity offering;
•our trustees control a significant percentage of our voting shares;
•shareholders could experience possible future dilution through the issuance of
additional shares;
•we are dependent on a small number of key senior professionals who are
part-time employees; and
•we currently do not plan to distribute dividends to the holders of our shares.

Overview


The Company is a Maryland real estate investment trust ("REIT") engaged in
investing in, owning and operating commercial properties. Future real estate
opportunities may include (i) acquisition and development of retail, office,
office warehouse, industrial, multifamily, hotel and other commercial
properties, (ii) acquisition of or merger with a REIT or real estate operating
company, (iii) sales of existing properties, and (iv) joint venture investments.
Substantially all of our business is conducted through our operating partnership
Pillarstone OP. We are the sole general partner of Pillarstone OP. As of March
31, 2022, we owned approximately 18.6% of the outstanding equity in Pillarstone
OP and we fully consolidate it on our condensed consolidated financial
statements.

As of March 31, 2022, the Company is a smaller reporting company current in its
quarterly and annual financial statement filings with the SEC, that may make
future real estate investments. There can be no assurance that we will be able
to close additional transactions.  Even if our management is successful in
closing additional transactions, investors may not value the transactions or the
Company in the same manner as we do, and investors may not value the
transactions as they would value other transactions or alternatives. Failure to
obtain additional sources of capital will materially and adversely affect the
Company's ability to continue operations, as well as its liquidity and financial
results.

Brief History

Pillarstone was formed on March 15, 1994 as a Maryland REIT. The Company
operated as a traditional REIT by buying, selling, owning and operating
commercial and residential properties through December 31, 1999. In 2000, the
Company purchased a software technology company, resulting in the Company not
meeting the qualifications to be a REIT under the Code. In 2002, the Company
discontinued the operations of the technology segment, and from 2003 through
2006, pursued a value-added business plan primarily focused on acquiring well
located, under-performing multifamily residential properties, including
affordable housing communities, and repositioning them through renovation,
leasing, improved management and branding. From 2006 until December 2016, the
Company continued its existence as a corporate shell current in its SEC filings.

On December 8, 2016, Pillarstone and Pillarstone OP entered into the
Contribution Agreement with Whitestone OP, a subsidiary and the operating
partnership of Whitestone, both of which are related parties to Pillarstone and
Pillarstone OP, pursuant to which Whitestone OP contributed to Pillarstone OP
all of the equity interests in four of its wholly-owned subsidiaries: Whitestone
CP Woodland Ph. 2, LLC, a Delaware limited liability company ("CP Woodland");
Whitestone Industrial-Office, LLC, a Texas limited liability company
("Industrial-Office"); Whitestone Offices, LLC, a Texas limited liability
company ("Whitestone Offices"); and Whitestone Uptown Tower, LLC, a Delaware
limited liability company ("Uptown Tower") that owned 14 real estate assets (the
"Real Estate Assets") for aggregate consideration of approximately $84 million,
consisting of (1) approximately $18.1 million of Class A units representing
limited partnership interests in Pillarstone OP issued at a price of $1.331 per
OP Unit; and (2) the assumption of approximately $65.9 million of liabilities by
Pillarstone OP (collectively, the "Acquisition").


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Impact of COVID-19


The ongoing COVID-19 pandemic has in the past and may continue to materially and
adversely impact and disrupt our business, financial condition, results of
operations and cash flows. Any future outbreak of any COVID-19 variants or any
other highly infectious or contagious disease could have a similar impact.

The impact of COVID-19, including any resurgences, future pandemics or other
health crises may adversely affect our business, financial condition, results of
operations, cash flows and market value. These type of health crises may impact
our business in the following ways:


•closures of, or other operational issues at, our properties resulting from
government or tenant action;
•reduced economic activity impacting our tenants' ability to meet their rental
and other obligations to us in full or at all;
•the ability of our tenants who have been granted rent deferrals to timely pay
deferred rent;
•an inability to renew leases or lease vacant space on favorable terms or at
all;
•tenant bankruptcies;
•liquidity issues resulting from reduced cash flows from operations;
•negative impacts to the credit and/or capital markets making it difficult to
access capital on favorable terms or at all;
•impairment in value of our properties;
•a general decline in business activity and demand for real estate transactions
adversely affecting our portfolio of properties and our ability to service our
indebtedness;
•supply chain disruptions adversely affecting our tenants' operations; and
•impacts on the health of our personnel and a disruption in the continuity of
our business.

Because substantially all of our income is derived from rentals of commercial
real property, our business, income, cash flow, results of operations, financial
condition, liquidity, prospects and ability to service our debt obligation would
be adversely affected if a significant number of tenants are unable to meet
their obligations or their revenues decline. The extent to which the COVID-19
pandemic, or a future pandemic, impacts our operations and those of our tenants
will depend on future developments, which are highly uncertain and cannot be
predicted with confidence.


Results of Operations

The following is a discussion of our results of operations for the three month
periods ended March 31, 2022 and 2021 and our financial condition, including:

•Explanation of changes in the results of operations in the Condensed
Consolidated Statements of Operations for the three month periods ended March
31, 2022
and 2021.


•Our critical accounting policies and estimates that require our subjective
judgment and are important to the presentation of our financial condition and
results of operations.

•Our primary sources and uses of cash for the three month periods ended March
31, 2022
and 2021, and how we intend to generate cash for long-term capital
needs.

•Our current income tax status.

The following discussion and analysis should be read in conjunction with the
condensed consolidated financial statements and notes thereto appearing
elsewhere in this Quarterly Report.

Comparison of the Three Month Periods Ended March 31, 2022 and 2021

Leasing Activity


For the three month period ended March 31, 2022, we executed 17 leases for a
total lease value of $955,000 compared to 23 leases for a total lease value of
$1.4 million for the three month period ended March 31, 2021.
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Results of Operations

The following provides a general comparison of our results of operations for the
three month periods ended March 31, 2022 and 2021 (dollars in thousands):

Three Months Ended March 31,

                                                                                       2022                   2021
Number of properties                                                                         8                     8
Aggregate GLA (sq. ft.)                                                                926,798               926,798
Ending occupancy rate                                                                       56   %                59  %

Total revenues                                                                   $       2,326            $    2,190
Total operating expenses                                                                 1,910                 1,970
Total other expenses                                                                       197                   203
Provision for income tax expense (benefit)                                                   7                    (7)
Net income                                                                                 212                    24
Less: Non-controlling interest in subsidiary                                               229                   109
Net loss available to Common Shareholders                                        $         (17)           $      (85)



Revenues from Operations

We had total revenues for the three month periods ended March 31, 2022 and
2021 of approximately $2,326,000 and $2,190,000, respectively, for an increase
of approximately $136,000, or 6%. The difference was comprised of a decrease of
approximately $24,000 in rental revenues, an increase of $129,000 in expense
reimbursements, an increase of $6,000 in other revenue, and a decrease of
$25,000 in bad debt, which is classified as a part of revenue. The majority of
the overall increase was due to higher reimbursements from common area
maintenance and unbilled recoveries from the prior year.

Expenses from Operations


Our operating expenses were approximately $1,910,000 for the three months ended
March 31, 2022 compared to approximately $1,970,000 for the three months ended
March 31, 2021, a decrease of approximately $60,000, or 3%. The overall decrease
was primarily due to a decrease in real estate taxes, offset by increases in
miscellaneous repairs, contract services, and electricity usage at our
properties for the three months ended March 31, 2022, compared to the three
months ended March 31, 2021. The primary components of operating expenses are
detailed in the table below (in thousands):
                                           Three Months Ended March 31,
                                                 2022                   2021        Change      % Change
Depreciation and amortization       $          484                    $   497      $  (13)          (3) %
Operating and maintenance                      771                        718          53            7  %
Real estate taxes                              328                        409         (81)         (20) %
General and administrative                     187                        207         (20)         (10) %
Management fees                                140                        139           1            1  %
 Total operating expenses           $        1,910                    $ 1,970      $  (60)          (3) %


Liquidity and Capital Resources

Cash Flows

As of March 31, 2022, our unrestricted cash resources were approximately
$4,342,000. We are dependent on cash generated by our ownership of the eight
Real Estate Assets to meet our liquidity needs.

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During the three months ended March 31, 2022, the Company’s cash balance
decreased by $864,000 from $5,206,000 at December 31, 2021 to $4,342,000 at
March 31, 2022. This decrease in cash was due to cash used in operating
activities of approximately $352,000, cash used in investing activities of
approximately $387,000 and cash used in financing activities of approximately
$125,000.


During the first quarter of 2022, Pillarstone Capital REIT ("Pillarstone REIT")
determined that it should be reimbursed for its operating and administrative
expenses from Pillarstone OP on a historical and ongoing basis in accordance
with the Pillarstone OP operating partnership agreement in which Pillarstone
REIT is the general partner and Whitestone OP is the limited partner. Whitestone
and Whitestone OP contested the reimbursement of expenses of approximately $1.8
million for the years ended 2017 through 2021 and Pillarstone REIT intends to
pursue the reimbursement from Pillarstone OP. The funds are in bank accounts
controlled by affiliates of Whitestone and Whitestone OP pursuant to Pillarstone
OP management agreements with those Whitestone affiliates. For financial
reporting purposes, Pillarstone REIT and Pillarstone OP report on a consolidated
basis, therefore, the reimbursement of Pillarstone REIT's expenses would not
change net income but only the allocations between controlling and
noncontrolling interests. For the three months ended March 31, 2022, Pillarstone
OP reimbursed Pillarstone REIT in May 2022 approximately $117,000 for a portion
of operating and administrative expenses and Pillarstone REIT will pursue
reimbursement from Pillarstone OP for the remaining amount of approximately
$59,000 that Whitestone and Whitestone OP have contested.

When Pillarstone REIT made its determination for reimbursement of its operating
and administrative expenses from Pillarstone OP for the years ended 2017 through
2021, Whitestone and Whitestone OP determined Whitestone OP should be reimbursed
for construction and lease commissions of approximately $1.4 million that it
paid on behalf of Pillarstone OP for 2017 and 2018. Pillarstone REIT and
Pillarstone OP requested additional information from Whitestone and Whitestone
OP for these expenditures. If any reimbursement is made to Whitestone OP, then
Pillarstone OP would have less cash available for operations and distributions
to its partners and Pillarstone OP's investment account with Whitestone OP would
be reduced.

Our ability to access the capital markets will be dependent on a number of
factors, including general market conditions and market perceptions about our
Company.


Future Obligations

None.

Long Term Liquidity and Operating Strategies

Historically, we have financed our long term capital needs, including
acquisitions, as follows:


•borrowings from new loans;
•additional equity issuances of our common and preferred shares and operating
partnership units; and
•proceeds from the sales of our Real Estate Assets.

From 2006 until December 2016, the Company continued its existence as a
corporate shell filing its periodic reports with the SEC so that it could be
used for future real estate transactions or sold to another company. During this
time, the Company was funded by its trustees who contributed $500,000 in
exchange for 125,000 Preferred C Shares and $197,780 in exchange for convertible
notes payable.

Subsequent to the Acquisition, Pillarstone has been developing strategies for
the Real Estate Assets in order to create value for the enterprise and our
shareholders and selling assets to pay off some of its debt. To implement the
strategy to create value with the Real Estate Assets, additional capital will
need to be raised.

Current Tax Status

As of March 31, 2022 and December 31, 2021, we had net deferred tax liabilities
of approximately $31,000 and $36,000, respectively. As of March 31, 2022, we
have an operating loss carryforward of approximately $94,000 available to be
carried to future periods.

The income tax expense (benefit) included in the condensed consolidated
statements of operations for the three months ended March 31, 2022 and 2021 was
comprised of the following components (in thousands):

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                                                                  Three Months Ended March 31,
                                                                  2022                      2021
Federal                                                   $               (5)         $         (18)
Texas franchise tax                                                       12                     11
Provision for income tax expense (benefit)                $                7          $          (7)



Interest Rates
The Company was not significantly affected by interest rates during the periods
presented in this report due primarily to the Company having approximately 100%
of its debt with fixed rates as of March 31, 2022.

Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have, or are likely to have, a
current or future material effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources.

Application of Critical Accounting Estimates


Our condensed consolidated financial statements are prepared in accordance with
GAAP, which require us to make certain estimates and assumptions. The following
section is a summary of certain estimates that both require our most subjective
judgment and are most important to the presentation of our financial condition
and results of operations. It is possible that the use of different estimates or
assumptions in making these judgments could result in materially different
amounts being reported in our condensed consolidated financial statements.

Revenue recognition. All leases on our properties are classified as
noncancelable operating leases, and the related rental income is recognized on a
straight-line basis over the terms of the related leases. For the three months
ended March 31, 2022 and 2021 we did not have a straight-line rent reserve
adjustment. Differences between rental income earned and amounts due per the
respective lease agreements are capitalized or charged, as applicable, to
accrued rents and accounts receivable. Recoveries from tenants for taxes,
insurance, and other operating expenses are recognized as revenues in the period
the corresponding costs are incurred. We combine lease and nonlease components
in lease contracts, which includes combining base rent and recoveries into a
single line item, Rental, within the condensed consolidated statements of
operations. We recognize lease termination fees in the year that the lease is
terminated and collection of the fee is reasonably assured.

Acquired Properties and Acquired Lease Intangibles. We allocate the purchase
price of the acquired properties to land, building and improvements,
identifiable intangible assets and to the acquired liabilities based on their
respective fair values at the time of purchase. Identifiable intangibles include
amounts allocated to acquired out-of-market leases, the value of in-place leases
and customer relationship value, if any. We determine fair value based on
estimated cash flow projections that utilize appropriate discount and
capitalization rates and available market information. Estimates of future cash
flows are based on a number of factors including the historical operating
results, known trends and specific market and economic conditions that may
affect the property. Factors considered by management in our analysis of
determining the as-if-vacant property value include an estimate of carrying
costs during the expected lease-up periods considering market conditions, and
costs to execute similar leases. In estimating carrying costs, management
includes real estate taxes, insurance and estimates of lost rentals at market
rates during the expected lease-up periods, tenant demand and other economic
conditions. Management also estimates costs to execute similar leases including
leasing commissions, tenant improvements, legal and other related expenses.
Intangibles related to out-of-market leases and in-place lease value are
recorded as acquired lease intangibles and are amortized as an adjustment to
rental revenue or amortization expense, as appropriate, over the remaining terms
of the underlying leases. Premiums or discounts on acquired out-of-market debt
are amortized to interest expense over the remaining term of such debt.

Depreciation. Depreciation is computed using the straight-line method over the
estimated useful lives of 5 to 39 years for improvements and buildings. Tenant
improvements are depreciated using the straight-line method over the life of the
improvement or remaining term of the lease, whichever is shorter.

Impairment. We review our properties for impairment at least annually or
whenever events or changes in circumstances indicate that the carrying amount of
the assets, including accrued rental income, may not be recoverable through
operations. We determine whether an impairment in value has occurred by
comparing the estimated future cash flows

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(undiscounted and without interest charges), including the estimated residual
value of the property, with the carrying cost of the property. If impairment is
indicated, a loss will be recorded for the amount by which the carrying value of
the property exceeds its fair value. Management has determined that there has
been no impairment in the carrying value of our real estate assets as of March
31, 2022.

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